Traders Await FOMC, Key Dollar Data

03/15/2011 3:01 am EST

Focus: FOREX

It's a busy week for US dollar news and data, beginning with today's FOMC rate decision. This week's trading should prove pivotal for USD against major currency counterparts like the euro.

By David Rodriguez of DailyFX.com

The US dollar finally showed signs of life through the past week of trading, initially bouncing noticeably against the euro and other currencies before pulling back into Friday's close. Surprisingly, large end-of-week declines dashed hopes that the dollar would carry bullish momentum into last weekend. Yet hope is far from lost for US dollar bulls; a hold of recent lows against the euro could keep an overall greenback recovery on track. Markets now look to this weeks US Federal Open Market Committee (FOMC) meeting as top event risk for the beleaguered domestic currency.

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Interest rate traders and analysts unanimously predict that the FOMC will leave interest rates unchanged through their upcoming rate announcement, but that does not rule out post-event volatility. It is admittedly unlikely that the FOMC will make any substantive shifts in its post-decision commentary. Core consumer price index (CPI) inflation remains relatively tame, and it seems improbable that the Fed would make a hawkish shift on price pressures through the foreseeable future.

Strong February employment numbers likewise make it less likely that central bankers will take a more dovish shift towards broader economic conditions. Of course, such muted expectations suggest that any surprises could prove especially market moving across US dollar currency pairs. It is difficult to predict exactly how the dollar may react ahead of the event. Market hesitation suggests the coming week could nonetheless prove pivotal for the US currency.

Recent Commodity Futures Trading Commission (CFTC) Commitments of Traders data shows that speculative traders remain heavily short the USD against a broad range of counterparts. Net positioning is at its most net-long the euro against the US dollar since the pair traded near the 1.45 mark in December 2007. And though one-sided sentiment is hardly a guarantee that an asset price will reverse course, any signs of material breakdown would likely involve rapid US dollar short covering and continued corrections. Previous sharp US dollar rallies initially suggested that the US dollar could recover from a bearish sentiment extreme. Yet the short-term outlook has become considerably less clear given last week's sharp greenback declines.

It remains as important as ever to watch how the US dollar behaves in the next few days. Can it continue its earlier move higher against all major counterparts, or is last week's sudden selloff the sign that the USD bounce was a momentary blip?

We have made little secret of our dollar-bullish bias for some time now, and indeed, many of our analysts called for continued strength on earlier reversals. A key factor to watch is whether the EUR/USD holds recent highs. If the dollar is able to hold significant lows, a short-covering-based rally becomes that much more likely.

By David Rodriguez, quantitative strategist, DailyFX.com

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